A large number of tech businesses and financial bankers are turning to new age currencies like Bitcoin and Ethereum. Both private and public organizations have looked at blockchain to understand how it can be used for practical applications.
The rising public interest in digital currencies has not gone unnoticed by major economists.
Six months ago, the IMF director Christine Lagarde declared that blockchain based cryptocurrencies will soon challenge governmental monetary policies. She had predicted that people would prefer to use cryptocurrencies once they become as convenient and cheap as regular money.
Every government tries to control and regulate the money supply in the markets to keep inflation in check. If people started using digital currencies for daily transactions more commonly, it would leave the government’s monetary policy ineffective.
A Government Backed CryptoCurrency
A team of researchers from the Yale University recently proposed the FedCoin, a dollar backed cryptocurrency that would operate through a P2P network. The researchers believe that the FedCoin would let the government control the money supply more effectively by removing the role of traditional bankers as middlemen.
Traditionally, bankers use the deposits maintained by account holders to advance loans. The multiplier effect allows the banks to turn $1 into $10. Risk is mitigated through the fractional reserve system. The fractional reserve is a percentage of the deposits that the banks are required to hold in their accounts. It provides liquidity in case a large number of depositors suddenly want to withdraw their money from the bank.
If cryptocurrency replaces the fiat currency, people would no longer need to keep their savings in a bank. The currency can be easily stored in an e-wallet on a digital device, like a tablet. Any savings that are not needed for daily use can be invested into long term assets like mutual funds, stocks and bonds.
This would obviously create greater liquidity for people while allowing the government direct control of the money in circulation.
A study completed by the Bank of England revealed that a central bank cryptocurrency could boost GDP by 3%. The study showed that most of these gains would be a direct consequence of shrinking costs of tax rates.
The Intermediary Role of Banks Would Diminish
Any government initiatives to support existing cryptocurrencies or create a new centralized FedCoin are opposed by banks. Analysts from JPMorgan for instance warned that a centralized crypto dollar would severely endanger the intermediary function played by commercial banks.
With a centralized cryptocurrency, people would have no need to keep their money in the bank. This leaves banks with two options at this point.
The first option is to strongly oppose any innovations or adoption of crypto technologies. Banks have strong lobbies in government circles and they can create hurdles to cryptocurrency acceptance or delay the rate of adoption.
The second option is to innovate. Banks can lead the way in fintech and stand to gain the most benefit by creating monetary platforms for the future. Some banks have chosen this path and working with developers to create their own blockchain platforms.
The Government’s Role
The government has a strong role to play in the future of cryptocurrency, centralized or not. Tougher legislation on existing currencies or creating something like the FedCoin can send the existing currencies into hyper drive.
We have seen these effects in recent months. Bitcoin dropped to its lowest value in Feb when a key cryptocurrency hearing took place in the U.S. Senate.
The Commodity Futures Trading Commission and SEC have recommended strong regulatory control for the crypto markets. This has severely stifled the growth of the markets.
Still, many experts believe that the Feds will not stamp out cryptocurrencies completely, as they want to keep their options open. A working cryptocurrency could be the only way out for the government in case of a financial collapse.